Thursday, September 4, 2014

Speaking as a Canadian who has seen several Quebec referendums on sovereignty, let me put in my two cents worth on the prospect of a Scottish currency union with the rest of the UK. Business Insider recently published an alarmist article about the implications of a Yes vote for Scottish independence:

Three separate reports published by economic experts warn a separate Scotland would require deep public spending cuts and lead to higher interest charges for mortgage holders.

Scottish independence would herald a new wave of painful public spending cuts, an increase in mortgage costs and a eurozone-style currency crisis, economic experts have warned amid claims “the penny is finally dropping” about the dangers.

City analysts from Goldman Sachs and Berenberg, a German-based multinational bank, published reports concluding a Yes vote would force Scotland into deeper austerity, requiring a “significant reduction in the provision of public services” to gets its finances in order.

In a separate analysis, Iain McLean, professor of politics at Oxford University, predicted every Scot would be £480 worse off under independence now thanks to sharply declining oil revenues.

All three agreed that a separate Scotland would pay a higher interest rate on its borrowing, an additional cost that would be passed onto borrowers and mortgage holders.

David Cameron on Wednesday warned this hike would be even higher if Alex Salmond made good his “chilling” threat to refuse to accept a share of the U.K.’s national debt, adding the consequences would be “crippling” for the Scottish people.

Goldman Sachs also predicted a eurozone-style financial crisis could hit both Scotland and the remainder of the U.K., with uncertainty over a currency union causing a run on assets and deposits based north of the Border.

Alex Salmond has said the three main U.K. parties are bluffing by ruling out a formal deal to share the pound, but the global investment bank concluded the warning was “credible.”

Scotland can use the Pound
First of all, if an independent Scotland chooses to use the Pound, no one can stop them, as the Yes side points out (emphasis added):

The Scottish Government proposes that an independent Scotland will continue to use the pound and enter into a formal currency agreement with the government of the United Kingdom – as explained in this article.

In adopting this policy, the Scottish Government has accepted the recommendation of a group of independent and internationally renowned economists -the Fiscal Commission - that a formal currency union is the best way ahead. A formal currency union would provide the right balance of autonomy for government and stability for business, as well as straightforward access to markets in the remainder of the UK.

It is important to remember, however, that Scotland cannot be stopped from continuing to use the pound, which is a fully tradeable currency. As No leader Alistair Darling was forced to admit recently, "of course Scotland can use the pound".

Considerable costs to using GBP
However, there are costs. The first is the issue of whether Scotland adopts a de facto currency peg or enters into a currency union with the rest of the UK. If so, what does the currency union look like?

For instance, Hong Kong has pegged the HKD to the USD for decades. The USD is also freely used as a second currency in many countries around the world. However, the HKMA does not have a seat at FOMC meetings and the Fed does not take into consideration the effects of its monetary policy decisions on HK or other countries that use the USD. Hong Kong tycoons are acutely aware of US monetary policy. At times, Hong Kong may either be importing either inflation or deflation from the US depending on the differential in growth rates.

Would the BoE go so far as to allow Scotland representation at MPC? If not, Scotland could see a wildly inappropriate monetary policy for its economy. If the UK economy heats up, but Scotland is weak, the act of BoE tightening would send the Scottish economy into a deeper recession than if it had its own currency. No doubt Scots saw first hand in the last few years the effects of a currency union in the eurozone without a political union.

Is this what "independence" would look like? To see the Scottish economy be at the whims of BoE decisions?

On the other hand, would the BoE actually allow representation from a foreign government or entity at to have sway on its monetary policy decisions? Even so, how much influence does Greece or Portugal have on ECB deliberations?

Mark Carney, the Canadian head of the BoE who undoubtedly understand these issues, noted that while there could be negotiations, a currency union requires "some ceding of national sovereignty" (vias the Guardian):

Any negotiations on a currency union would involve major concessions by both sides. The UK would have to abandon the clear commitments of Osborne, Alexander and Balls. But Salmond would have to acknowledge for the first time that joining a currency union would involve the loss of some sovereignty after Mark Carney, the governor of the Bank of England, said in Edinburgh in January: "A durable, successful currency union requires some ceding of national sovereignty."

During the debate leading up to Quebec referendums, the Oui side has always held out the siren song of an independent Quebec using the Canadian Dollar as a currency. Nothing will change, they assured the Quebecois. However, serious sovereigntists who have studied the issue have concluded that Quebec needed its own currency in order to be truly independent.

If the referendum were to pass, adopting the another currency for use in a newly independent country is an idiot idea, for both Quebec and Scotland. An currency and economic union without a political union is a potential disaster in the making. But then, the last time Europe saw both an economic and political union was in 1941 under Hitler - and look how well that turned out.

2 comments:

You obviously don't understand the economics of a currency union. If Scotland had its own currency and its economy weakened relative to the rest of the UK, it could devalue in order to make its goods and services more competitive. You don't have to print money, though that is an option.

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